Returns to Investing in Commodity Futures: Separating the Wheat from the Chaff

Abstract

Commodity futures investment grew rapidly after its popularity exploded in the mid-2000s. However, real-time performance has been disappointing. Our analysis shows that the disappointing commodity returns were not driven mechanically by contango or negative "roll yields." We show that the expected return to individual commodity futures is near zero before expenses, which implies net losses (before interest earnings) will be equal to order execution and operating costs estimated at 3%-4% per year. Finally, it is likely that rapid increases in commodity prices during 2004-2008 skewed investor return expectations upward much like it did in the early 1970s.

Who Wins and Who Loses? Trader Returns and Risk Premiums in Agricultural Futures Markets

“…The most plausible explanation for the large losses is the order flow impact associated with roll trades. Overall, our findings are consistent with Irwin et al's (2020) conclusion that the expected return to long‐only commodity futures investments is negative after accounting for costs.…”

“…However, recent statistical evidence on risk premiums in agricultural futures prices is consistent with a negative risk premium. Irwin et al (2020) investigated daily returns for nineteen storable commodity futures markets over July 1959 through June 2017. When considering only the twelve agricultural futures markets included in their study, the average return for the entire sample period was −2.2% per year.…”

“…We provide new evidence about risk premiums in agricultural futures markets by taking advantage of the large-scale emergence of commodity index 12 It is important not to confuse the order flow impacts of CIT roll trades with the common (and false) assumption that CIT returns are mechanically related to the term structure of futures prices. See Bessembinder (2018) and Irwin et al (2020) for more detailed discussion on this point. 13 The 3.6% order flow cost estimate is an average across all nineteen commodity futures markets in Mou's study, which includes agricultural, livestock, energy, and metals markets.…”

“…See the accompanying feature article by Irwin et al (2020) for a detailed presentation of the theory of normal backwardation in storable commodity markets.…”

“…It is important not to confuse the order flow impacts of CIT roll trades with the common (and false) assumption that CIT returns are mechanically related to the term structure of futures prices. See Bessembinder (2018) and Irwin et al (2020) for more detailed discussion on this point.…”